Can Americans Afford To Be Old?

The need to solve the retirement crisis is defying today’s political divisiveness by giving us a rare example of bipartisanship. In the last month, four experts of varying political stripes called for creation of mandatory retirement savings accounts to replace our failed “do-it-yourself” voluntary system. This includes myself and my Rescuing Retirement co-author Tony James, president of private equity firm Blackstone; Jason Fichtner, a former Bush administration economist; and Third Way, a centrist Democratic think tank.

And while there are significant disagreements in the details, it is nothing less than a sign of the growing political will to take bold action to ensure our workers can retire and our retirees stay out of poverty.

Unfortunately, the shared call for mandatory retirement accounts neglects the foundation of retirement security, Social Security. The protection and expansion of this program is a necessary starting point for securing and building retirement security. To be clear, we believe that bold proposals for individual retirement accounts – as necessary as they are – simply will not work without first strengthening Social Security.

Polls of the American public persistently report two results. First, that Social Security is highly popular, considered efficient and effective. And second, that over half of Americans don’t think they will have enough money in retirement. On both, the public is spot on. Without reform to bridge the gap between Social Security and private savings, when they reach age 65, 30%, or 21 million Americans ages 50-60, will be poor or near poor as retirees.

As economists, we believe it’s possible to fund both an expansion of Social Security and mandatory individual retirement accounts on top of Social Security.

To ensure all workers a secure retirement and the end of elderly poverty would require an additional $500 billion in retirement contributions from workers, employers, and the government. While less than 3% of GDP, $500 billion is not trivial. Rather, it is similar in magnitude to the 10-year cost of $5.5 trillion to fund the recent GOP tax cut.

How does this work? First, every worker would pay an additional 5.8% of pay toward their retirement security, or about 80 cents per hour. This breaks down into three parts.

First, 2.78% to secure Social Security (one way among many to provide needed revenue). This would ensure workers receive their full and promised Social Security benefits and provide retirees with an average of 36% of their pre-retirement income.

Second, an additional 0.02% would raise the special minimum benefit to bring almost every elder above the poverty line. The special minimum benefit places a floor under the benefits of lifetime low earners, but has eroded over time and now almost no new claimants qualify.

Third, 3% to fund mandatory individual savings accounts for retirement. Alone, this contribution is unlikely to permit all workers to maintain their living standards in retirement. However, it is designed to add on to retirees’ monthly Social Security benefit to ensure they can live well clear of poverty or near poverty. We could follow the lead of Australia’s mandatory retirement savings program, which started with a 3% required contribution and is now up to 12%. The program will also allow for those who want to contribute more to do so.

Accumulating retirement savings is just the beginning. How the money is invested matters, as does how savings are paid out to retirees as well as how retirement tax breaks are distributed to low-, middle-, and high-income workers. The Ghilarducci/James proposal for Guaranteed Retirement Accounts (GRAs) calls for pooled investments to ensure workers earn the highest risk-adjusted returns possible, guaranteed principal to make sure workers’ contributions aren’t eroded by market risk, and annuity pay-outs to ensure retirees don’t outlive their savings. And lastly, the GRA includes an inflation-adjusted flat tax credit to incentive savings and ensure contributions are cost-neutral for those with low incomes.

Bottom line: If young workers and their employers, with assistance from a government refundable tax credit, paid 5.8% more – 2.78% in Social Security, 0.02% for poverty alleviation and 3% in an well-managed and invested retirement account - they would be secured from poverty and near poverty in retirement. Workers approaching retirement without adequate savings would have to increase their savings by considerably more that 3%. But these workers would be better off than they are today, with universal access to a low-cost savings retirement program. And the lesson of Australia is that the sooner the program starts, the sooner it matures.

This post was written with ReLab Research Director Anthony Webb and SCEPA Associate Director Bridget Fisher.